How does Greenblatt’s magic formula apply to MU and AAPL right now?

Hedge fund legend Joel Greenblatt founded one of the world’s most famous funds, the $6.8 billion Gotham Asset Management fund, back in 1985. The fund is closely tracked by investors around the world looking for a clue into how this top fund manager perceives the market. In the last quarter, Greenblatt made two very interesting moves in key stocks, namely Micron Technology Inc (NASDAQ:MU) and Apple Inc (NASDAQ:AAPL).

The Gotham Index Plus fund- Greenblatt’s favorite strategy’ uses a unique long-short strategy that involves using an offsetting leverage on the S&P 500 stocks to invest 90 percent in the index’s best stocks with a 90 percent short on the worst. Last year, this strategy proved very successful with the fund returning an 18 percent profit and beating most of its long-short peers. Specifically, Greenblatt is a fan of businesses that can grow without substantial capital, as well as businesses that have the potential to earn money efficiently.

“The only thing that could hurt us going forward is if the market continues up 15 to 20 percent a year for the next three to four years,” he said recently at a Reuters Summit. “That’s unreasonable to think, given current valuations. I think there will be normal to subnormal returns, and that’s fine for us.”

Further insights into this guru’s mindset can be gathered from Greenblatt’s bestseller The Little Book that Beats the Market where he sets out his magic formula for individual investing. At its heart the principle involves buying fundamentally strong companies at good prices and sticking with them through rough patches.

Now let’s take a closer dive into these two big portfolio moves in MU and AAPL:

Micron Technology

In the third quarter, Greenblatt took a leap of faith with chip stock Micron. He initiated a new position in the stock with the purchase of 1,477,788 MU shares valued at $58,121,000.

Cowen & Co analyst Karl Ackerman shares Greenblatt’s confident take on this stock. In a December 5 report, he notes that Micron will soon be reporting its results for the first fiscal quarter of 2018 on December 19. He believes that while the market is anticipating a strong first fiscal quarter beat, it is underestimating Micron’s potential for the second fiscal quarter. Indeed, he is anticipating upside of real ‘magnitude’ especially bearing in mind the stock’s robust average selling price (ASP) momentum. As a result, Ackerman reiterates his buy rating on the stock with a $50 price target (21% upside potential).

Note that Ackerman is less nervous than the rest of the Street about near-term weakness in NAND memory spot pricing as supply loosens. He points out that ~75% of industry NAND sales are done via contract- which will limit the potential volatility of prices. At the same time, he adds: “we take comfort in the trajectory of near term NAND pricing momentum as spot prices for mobile (eMMC) are 15% above CQ4 contract pricing, spot MLC is also 15% above contract and TLC spot/contract is in line.”

Crucially, his bullish take on the stock extends further than just the second fiscal quarter based on MU’s DRAM outlook. He says: “Longer term, we remain favorably disposed toward DRAM w/ our checks in Asia indicating just slightly lower capex plans from Samsung in C2018. While the NAND supply picture is somewhat opaque in 2H:18, we see no fundamental change for the next few qtrs.” Indeed, Ackerman says he is more confident in robust DRAM fundamentals compared to NAND for the next 12-24 months. He believes that Samsung’s focus on maximizing DRAM profits rather than increasing share will support a favorable DRAM supply/demand outlook for 2018.

As for Ackerman himself, TipRanks shows that he has a promising track record on the stock with a 67% success rate and 22.8% average return across his MU stock ratings. And if we take a step back, we can see that the Street in general has a very bullish take on Micron. Over the last three months this ‘Strong Buy’ stock has received 22 buy ratings and just 3 hold ratings. The average analyst price target of $53.48 translates into big upside potential of almost 30%.

Apple Inc

Interestingly, in Q3, Greenblatt displayed a bearish sentiment on one of the world’s best-known companies. He slashed the funds AAPL holding by 35% with the sale of 146,231 shares. Following this move, the fund now holds 272,095 shares with a value of $41,935,000.

Guggenheim’s Rob Cihra recommends buying, rather than selling, AAPL stock. In fact, on AAPL stock, Cihra comes out even more bullish than consensus due to iPhone ASPs and Services mix. For fiscal 2018, the analyst now stands 40 cents ahead of consensus and over $1 past the Street by fiscal 2019 and fiscal 2020. He even sees revenue growth to re-accelerate to 25% year-over-year- from the 19% figure he predicts for fiscal 2018.

“We continue to think this is Apple’s biggest iPhone cycle in 3yrs, and while that ironically makes its growing Services narrative less important to numbers near-term, Services gain importance over 3yrs and should already help boost AAPL’s P/E” states Cihra. With this in mind, Cihra reiterated his buy rating on AAPL on November 30 with a $215 price target (27% above the current share price).

He sees a substantial proportion of growth (70%) as driven by the iPhone from FY2017-2020- on the back of Apple’s big upgrades with the iPhone 8 and the iPhone X. The iPhone X is ramping up even better than expected and he says that investors who ‘sell the news’ are underestimating three key points. These are 1) pent-up iPhone demand after 2 weak years 2) multi-year new tech roll-out including OLED screens and augmented reality (AR) features and 3) meaningfully higher phone prices.

And his bullish thesis leads into his take on Apple’s App Store with its new AR apps. “We forecast App Store revenues +35%Y/Y in FY18E and see further upside potential as new AR apps become an incremental new category (e.g., games, e-commerce, education), where we believe Apple has a first-mover AND sustainable competitive advantage in both AR technologies and monetization” writes Cihra in his report.

This four-star analyst has a top track record on the stock according to TipRanks. Across his 37 AAPL ratings he boasts a success rate of 86% and an average return of 33.1%.

Overall, the Street has a ‘Strong Buy’ analyst consensus rating on Apple. This breaks down into 26 buy ratings versus 6 hold ratings published over the last three months. Meanwhile the average price target from these analysts of $187.97 indicates upside potential of close to 11% from the current share price.